The plot thickens in tax reform theater

Our one shared national moment of fiscal soul-searching is behind us for another year — of course I refer to the filing of tax returns — but tax reform theater in Washington, like the melody in the old Irving Berlin song, lingers on.

So while individual and business taxpayers watch to see whether any tax reform plan has any chance of passage, the Obama administration’s “Buffett rule” proposal succumbed Monday to the threat of filibuster by Senate Republicans. A House GOP plan purportedly aimed at giving small business a tax cut will come up this week to face its own doom.

Both proposals have been condemned, for different reasons, as gimmickry. The Buffett rule, which aims to ensure that millionaires and billionaires pay at least the same average tax rate as the average American, whoever that person is, would raise somewhere between $47 billion and $160 billion over 10 years, depending on how you count and the fate of the Bush tax cuts. Obviously that wouldn’t cut too deeply into a budget deficit of $1 trillion plus.

The tax cut championed by House Majority Leader Eric Cantor (R-Va.) is a $46-billion giveaway to the wealthy in small-business sheep’s clothing. Even the business-oriented Tax Foundation think tank believes it’s a bad idea — “easily gamed” and poorly targeted.

On the one hand, a device that recognizes the increasing inequality between America’s wealthy and not wealthy, and recognizes tax policy’s traditional role in combating such inequality. The gap has only widened during the recession and the nascent recovery. On the other, one based on draping the wealthy in the sainted mantle of small business, even though most of the beneficiaries of the gimmick would hardly meet the popularly quaint image of “small business.”

Let’s examine their underlying principles in turn.

The idea that concentration of wealth corrodes the body politic was accepted by the founding fathers. In 1785 Thomas Jefferson, drawing a lesson from his travels in pre-revolutionary France, advised James Madison that “legislators cannot invent too many devices for subdividing property.” Among his suggestions was “to exempt all from taxation below a certain point, and to tax the higher portions of property in geometrical progression as they rise.” (Sound familiar?) The alternative, he counseled, was the squandering of resources through unemployed labor and uncultivated land.

Our modern political fathers haven’t even drawn lessons from the recent economic crisis, much less conditions in the 1780s. As Berkeley economist Emmanuel Saez has observed, downturns typically loosen the hold of the top echelon on concentrated wealth and income, but the effect is only temporary unless it’s bolstered by “drastic regulation and tax policy changes.” The last time that happened was after the Great Depression, when New Deal programs reduced income concentration until the 1970s.

In this recovery, he finds, the top 1% have captured 93% of total income growth. That’s the most unequal performance, by far, since before the Clinton expansion of the 1990s. As Marianne Bertrand and Adair Morse of the University of Chicago contend, the struggles of the middle class to keep up with the consumption levels of the ever-richer contribute to low savings rates and high consumer debt, both impediments to growth. The Buffett rule may not solve the federal deficit or do much to stem rising income inequality, but at least it’s a hint that someone in government understands the real issue.

The Buffett rule’s supporters have never concealed the point of its symbolism. Can the same be said of the Small Business Tax Cut Act of 2012?

The measure “will put more revenues, more money into the hands of small business owners so that they can reinvest those funds to retain and create more jobs and to grow their business,” Cantor said upon its introduction last month. The idea is to let every business with 500 employees or fewer take a one-time tax deduction on 20% of its profits. As the Tax Foundation noticed, that poses a quandary for a business pondering whether to hire its 501st employee — “not the kind of incentives we want in the tax code.”

Another flaw is that the bill removes provisions in an earlier version that would have disqualified firms in finance, law, healthcare and other high-income, low-headcount fields. (This may be why it has the support of the American Dental Assn.) It would apply to partnerships, limited liability companies, medical offices, sole proprietorships and many other “pass-through” business arrangements, so called because their tax liabilities pass through to their owners.

That could mean a tax cut for law firms, hedge funds and sports teams. Unlike the plan being drafted by Senate Democrats that would tie a tax cut to actual hiring, the Cantor measure covers any entity claiming business income, regardless of its hiring plans. “If all it takes is a little business income to reduce one’s overall tax bill by 20%,” observes the Tax Foundation’s William McBride, “we can expect to see a lot more yard sales and EBay entrepreneurs.”

The flaw is that the bill confuses business ownership with business income. This reflects conservative orthodoxy, which holds that allowing the Bush tax cuts to expire for high-income taxpayers amounts to an attack on small business.

In fact, as the congressional Joint Committee on Taxation found in 2010, only 3% of all taxpayers reporting business profits fell into the top two brackets (this year, the income threshold for married taxpayers in those brackets would be $217,000). But those taxpayers accounted for 50% of all reported U.S. business income. Nor were their businesses uniformly “small”; nearly 20,000 partnerships and privately held S corporations reported revenue of more than $50 million.

“Lawmakers should take care not to assume that all pass throughs are small businesses,” Donald B. Marron, director of the Urban Institute/Brookings Institution’s Tax Policy Center, warned Congress last year.

Yet the Cantor bill concentrates its fire on the biggest income earners, provided they have at least a technical claim to being small businesses. The Tax Policy Center calculates that fully 49% of the tax cut would go to taxpayers earning more than $1 million, who make up 0.3% of all taxpayers. Yet to the extent they’re SBINOs (small businesses in name only), awarding them this particular tax cut would do nothing to spur the economy. Indeed, it may have the opposite effect, by increasing the deficit and making it harder to deliver tax benefits to the people who really need it — and who would spend the money in the consumer economy, namely the middle and working classes.

This is why making tax policy is so hard. It’s not about government finance, or economics, or industrial planning, or social policy. It’s about all those things, and how they interact with one another. The only way to keep all those factors straight is to focus on the goal one is trying to achieve — an economy in which the benefits of growth are fairly distributed, or one in which the same few people pocket all the gains?

Michael Hiltzik’s column appears Sundays and Wednesdays. Reach him at mhiltzik@latimes.com, read past columns at latimes.com/hiltzik, check out facebook.com/hiltzik and follow @latimeshiltzik on Twitter.